The prize pool for environmental innovation challenges increased twelvefold in the past ten years—and shows no sign of easing up. But does crowd-sourcing solutions pay off for the world as well as for the winners?

By Marc Gunther

The ceremony had all the pomp of the Oscars, minus the gowns. Musical fanfares greeted each presenter. Politicians delivered windy speeches. A global audience watched live (and a prime-time special followed on The Discovery Channel) as the winners of the Progressive Automotive X Prize were announced on September 16, 2010, in Washington, D.C.

The $5 million grand prize went to a startup company called Edison2, whose founder, Oliver Kuttner, had assembled a team of professional motor-racing engineers to rethink the fundamentals of the automobile. Their winning entry, aptly named The Very Light Car, weighs just 830 pounds, travels 100.3 miles on a gallon of gas, and represents a radical departure from any other car on the road today. “That’s what this competition is all about: advancing the science behind automotive technology to create revolutionary change,” declared Glenn Renwick, chief executive of Progressive Insurance, which put up $10 million in total prize money. Peter Diamandis, founder and chief executive of the X Prize Foundation, was characteristically effusive. “We’re living in a day and time where literally anything is possible,” he declared, “where a man or woman who is passionate and driven can go out and build a spaceship or a 100-mile-per-gallon car. This is only the beginning.”

But the beginning of what? Don’t expect to see the Edison2 on the roads anytime soon, if ever; so far, no auto-maker has stepped forward to license the design. When it comes to prizes, though, we’re well past the beginning. Thanks in part to the influence of Diamandis and the X Prize, nonprofits, governments, and corporations are turning to prizes to spur innovation—particularly environmental innovation.

It’s not hard to see why. Unlike conventional research and development, prizes pay for performance, not just the effort. They call attention to important issues. And they open up problems to anyone with a good idea (or a bad one), getting beyond insiders or accredited professionals. “There are so many more ideas and possible solutions out there in the world than any given company or organization can tap into,” says Beth Trask, who oversees prizes for the nonprofit Environmental Defense Fund. Some people call this Joy’s Law—after Bill Joy, a founder of Sun Microsystems and a venture capitalist who once said: “No matter who you are, most of the smartest people work for someone else.”

Often, though, it takes insiders as well as outsiders to solve big problems, as Edison2’s travails suggest. Prizes can clearly drive technological innovation, but big environmental problems such as climate change and biodiversity loss are shaped by politics, economics, and culture as well as by science and engineering. And that raises a question: Once the buzz dies down, can prizes generate solutions that scale up to deliver lasting environmental change? Put another way, do they pay off for the world as well as for the winners?

History tells us that prizes can deliver big social benefits. Before the growth of research universities and global corporations with R&D labs, prizes were the pathway to solving many scientific problems, according to Karim Lakhani, a faculty member at Harvard Business School who studies open innovation. The Longitude Prize, established in 1714 by the British government, inspired clockmaker John Harrison to develop the marine chronometer, enabling ships to know their locations at sea. In 1795, Napoleon offered a 12,000-franc prize for a method of food preservation to feed his army when “an invaded country was not able or inclined to sell or provide food,” according to Knowledge Ecology International. The 1809 winner, French confectioner Nicolas Appert, invented the basic method of canning food still in use today. Nearly a century later, America’s biggest manufacturer of billiard balls, Phelan & Collander, offered $10,000 in gold to anyone who could come up with a substitute for the elephant ivory used in billiard balls. That may have been the first prize designed to promote environmental protection—although the solution turned out to be celluloid, one of the first industrial plastics.

Most famously, Charles Lindbergh flew the Spirit of St. Louis from New York to Paris in 1927 to win a $25,000 prize offered by New York hotelier Raymond Orteig. It was Lindbergh’s story that inspired Peter Diamandis, who has had a lifelong fascination with space travel, to announce the first X Prize in St. Louis in 1996. Eight years later, aerospace designer Burt Rutan, financed by Microsoft billionaire Paul Allen, won what had become the $10 million Ansari X Prize for developing a private spacecraft—after 26 teams from seven nations spent more than $100 million on the competition. Since then, another $1.5 billion in private and public funds has been invested to build a private spaceflight industry. Says Diamandis: “We’re on the verge of the greatest exploration that the human race has ever known.”

A 50-year-old philanthropist and entrepreneur who earned an MD degree from Harvard but never practiced medicine, Diamandis has become the world’s leading evangelist for the power of prizes. The success of the space-travel prize led him to organize prizes in environment, genomics, and health care; his team is currently working on prizes in education and global development, too—on the theory that no problem is too big to be solved by the collective intelligence of mankind. “Out there in the world today, there are billions of innovative people,” Diamandis says. “How do you get them to spend their time working on your problem? When you’re looking for a needle in a haystack, an X Prize allows the needle to come to you.”

The X Prize phenomenon has set off a boom in the prize business. A 2009 McKinsey and Company report identified 219 prizes worth at least $100,000, more than 60 of which had debuted since 2000. (1) Total prize money: $315 million. (Some prizes reward past achievement, but most are competitions focused on a future goal, the report says.) Last year, the Obama administration created challenge.gov, a portal that lists government prizes ranging from a NASA green-flight challenge to build a super-efficient aircraft, to an EPA essay contest inviting contestants to write Six Words for the Planet. McKinsey said 80 major prizes are devoted to energy and the environment.

Some have already delivered results. When Congress enacted legislation in 2007 to create a $10 million prize for an efficient light bulb to be manufactured in the U.S., Philips, the world’s largest lighting company, accelerated its work on LED technology. Last year, a Philips 60 watt–equivalent LED bulb was awarded the L Prize. The new bulb went on sale on Earth Day 2012. “Would it have happened anyway?” asks Ed Crawford, president of Philips North America. “Absolutely. But we’re at least two years ahead of where we would have been.” The Philips LED bulb, which had to meet rigorous Department of Energy standards to win, is 83 percent more efficient than a traditional incandescent bulb and lasts 20 to 30 years, depending on usage. It should save customers money, despite a steep $50 price tag. “It really is a breakthrough product,” Crawford says.

Last fall, with the support of environmental philanthropist Wendy Schmidt, the X Prize Foundation awarded $1.4 million in prizes to improve the ways oil is cleaned up after spills. Elastec Marine, a private company, won the $1 million first prize in the competition by developing technology that sucked up oil at a rate of 4,670 gallons per minute—more than three times the industry norm. In the meantime, the World Wildlife Fund has been running its International Smart Gear competition since 2004, awarding prizes for fishing gear that reduces the capture of unwanted marine life—commonly known as bycatch. Several winning entries have been commercialized, and a couple of inventions have become mandatory in selected fisheries.

None of those competitions cast a wide net (if you’ll pardon the pun) in the search for solutions. It was almost a given that a lighting company would win the L Prize, and no landlubber is going to invent “greener” fishing gear. But other prizes are now using the power of the Internet to crowd-source solutions. InnoCentive, a company spun off from pharmaceutical giant Eli Lilly, acts as a clearinghouse for companies and nonprofits, including Environmental Defense Fund, to tap into its community of more than 250,000 problem solvers from all over the world who compete for cash prizes. “Challenge-driven innovation,” it’s called, and it seems to work. When Harvard’s Lakhani studied InnoCentive, he found that its diverse community of Internet-connected scientists and engineers found solutions to about “one-third of a sample of problems that large and well-known R&D-intensive firms had been unsuccessful in solving internally.” So-called outsiders, he found, did best because they looked at problems with fresh eyes.

Last year, for example, in a challenge put forth by Environmental Defense Fund, Patrick Fuller, a graduate student in chemical and biological engineering at Northwestern University, won $5,000 for an idea about capturing agricultural runoff and using the nitrate-rich water to feed algae. Iowa soybean and corn farmers will now try it out. Environmental Defense Fund is also using the InnoCentive platform to address two problems associated with electronics recycling. Together with the Consumer Electronics Association, they sponsored a competition to find creative ways to repurpose old cathode-ray picture tubes. And with EMC Technologies, a major Massachusetts-based firm, they are offering a prize for technologies that keep track of discarded electronics to ensure they are handled responsibly. “Within those big, gnarly, system-wide problems,” EDF’s Beth Trask says, “we can carve out discrete questions that need to be solved, often of a technical or scientific nature.” Focus is the key to managing challenge-driven innovation, explains Dwight Spradlin, CEO of InnoCentive. “If I had 60 minutes to save the world,” he says, “I’d spend 55 minutes asking the right question.”

For General Electric, which invited entrepreneurs to propose new business ideas and technologies through a competition called the Ecomagination Challenge, the key to making profitable use of the ideas is what happens after prizes are awarded. Initially, GE and four venture-capital firms put up $200 million to find and fund promising technologies for the smart grid and to promote energy efficiency; they attracted more than 1,500 business plans and invested $85 million in startups.

Then, according to Mark Vachon, vice president of GE Ecomagination, GE set out to test the new technologies with customers and, if needed, bring its own know-how to bear. “We have an amazing infrastructure,” he says. “Five global research centers, 1,500 PhDs, as well as access to thousands of customers.” So, for example, GE invested in a company called Oblong Industries, which surfaced during the Ecomagination Challenge and makes “gesture-based operating systems” such as those seen in the movie Minority Report. GE also licensed Oblong’s technology for its Smart Grid software, which it is testing with utility companies. “The prize can get ideas into a funnel, but it can’t get them to scale,” says Vachon. Only big companies, governments or consumers can do that.

Getting new technologies to scale, as Vachon notes, takes more than a contest. That’s the challenge facing the X Prize Foundation, which has proven that it can uncover and showcase breakthrough innovation, such as private space travel or The Very Light Car. But Diamandis and his team have no desire to run the equivalent of a high-school science fair for well-to-do entrepreneurs; they want to change the world. Diamandis likes big, attention-getting ideas not for their own sake, but because he wants X Prizes to have an impact on “hundreds of millions, if not billions, of people,” he told me. The trouble is, well-entrenched industries such as the auto industry may resist breakthrough ideas because they’re tied to old ways of doing things. The automakers, after all, know how to build small, fuel-efficient cars; they haven’t done so to this point except when forced to by the government, because they don’t think consumers will buy them.

Edison2 and its Very Light Car have yet to overcome those institutional obstacles. Eighteen months after winning the X Prize, Edison2’s engineers are still hard at work, trying to design a car that will be efficient and affordable, with all the comfort and safety buyers have come to expect. The Very Light Car set a record for aerodynamic efficiency at a General Motors wind tunnel, and an all-electric version achieved an EPA-accredited 350 miles per gallon–equivalent rating. But, although Oliver Kuttner and his crew have had numerous conversations with U.S. and foreign automakers, none has yet stepped up to license their car design for manufacturing. Nor has any manufacturer invested in Edison2. It’s not clear that the auto industry—or car buyers—is prepared to embrace the kind of radical change embodied by The Very Light Car and encouraged by the X Prize.

A new environmental X Prize under development could run into similar obstacles. A $10 million prize for carbon capture and recycling aims to do nothing less than transform the energy and climate landscape by turning carbon dioxide emissions from a waste stream into an asset. It’s being designed to uncover ways that carbon can be beneficially and efficiently re-used—as a feedstock for fuels, plastics, chemicals, fertilizers, building products, or other valuable materials. If all goes according to plan, the prize would solve a problem that has stumped the federal government: although Congress has appropriated $6 billion to develop ways to capture CO2 and store it underground, its efforts have stalled because there’s no way to pay for carbon capture and sequestration. Recycling carbon, by contrast, would generate revenues—at least in theory.

Tri-State Generation and Transmission, a wholesale electric-power supplier owned by 44 electric cooperatives in the West, has agreed to put up $10 million for the carbon prize. The company generates most of its electricity by burning coal and natural gas. “We’ve been looking at what do we do with carbon,” says Jim Spiers, a senior vice president at Tri-State. “We’re looking for a totally different capture solution that will create a monetizable by-product.” The X Prize Foundation is now trying to raise the money needed to run the competition. Success in carbon capture and recycling will require shaking up the heavily regulated, slow-moving utility industry, which will be no easy feat.

Long odds don’t deter Diamandis. He is an inveterate optimist. (His new book Abundance: The Future Is Better Than You Think is not for the cynical among us.) Along with its environmental work, the foundation is developing challenges in agriculture, education, and health care in the global South, aiming at discovering scalable ways to “create wealth and uplift entire populations from poverty.”

Isn’t that a lot to ask of a prize? I ask Diamandis. Maybe, he replies, but we don’t know yet what prizes can or cannot do. “Can they change rules and regulations? Can they change a marketplace? Can they change human behavior? We’re going to experiment. We’re going to find out.” ❧

Marc Gunther is a contributing editor at Fortune magazine, a senior writer at Greenbiz.com, and a blogger at www.marcgunther.com. His ebook Suck It Up: How Capturing Carbon from the Air Can Help Solve the Climate Crisis was recently published as an Amazon Kindle Single.